The RealReal Got a Beautiful Start, But This Metric is the Key to its Luxurious Valuation

As the leading online reseller of previously-owned luxury items, The RealReal (ticker: REAL) has a chance to disrupt the industry with a combination of trust, quality, and ease of use that brick-and-mortar shops can’t offer. The question for investors is whether they believe in the company’s path to profitability.

The company, which focuses on high-end labels such as Hermès, LVMH Moët Hennessy’s Louis Vuitton, and Kering SA’s Gucci, saw its shares scream to $28 on Friday morning after pricing at $20 each, above the indicative range of $17 to $19. That gives the company, founded in 2011 by CEO Julie Wainwright, a valuation of $2.5 billion.

The big attraction to investors is the massive size of the second-hand luxury market, which in the U.S. alone is $198 billion according to estimates by Frost & Sullivan. That compares with REAL’s $711 million in gross merchandise value (GMV), or total value of goods sold, last year. REAL is far and away the preferred online consignment company of its kind and the size of the market suggests it can keep up its heady pace of revenue growth, which hit 55% last year.

The big question – which is common to many technology IPOs – is if and when the company can become profitable. And REAL is still losing heaps of money: The company posted negative adjusted Ebitda of $59 million in 2018 on revenue of $207 million.

Fortunately, investors have some reason to be optimistic those losses will narrow. Indeed, margins are moving in the right direction. The negative Ebitda margin narrowed to -29% last year from -33% in 2017. And the company has set a long-term target for a positive 25% Ebitda margin.

How will REAL get there? First, the company can continue to increase order size, which is already several hundred dollars. So long as customers continue to trust the company’s ability to delivery authentic items, that should happen naturally over time.

Second, REAL can probably push its so-called take rate, or percentage of each order it keeps as a fee, even higher. The take rate edged up to 35.5% last year from 33.7% in 2017. Because REAL is able to sell items very quickly, consignors tend to let it take a large cut.

Third, REAL has established a very loyal customer base, with consigners often becoming buyers and vice versa. The company says marketing costs to acquire one new buyer are recovered within one year and are becoming cheaper. That’s already impressive, but REAL can become even more efficient over time as customers join with minimal marketing and stick around for years.

Last, the company will see fixed costs such as technology spending and payroll stabilize over time. That is unlikely to happen right away as the company remains in an investment phase, but should help a few years out.

At $28 a share and assuming 50% sales annualized growth, REAL is trading around 4.3 times 2020 sales. A good comparable company is Farfetch, another category leader that curates new luxury items from boutiques around the world. It trades at an enterprise value of 4.8 times 2020 sales, which are expected to rise 33% from 2019, according to Sentieo.

By that comparison, REAL shares should have room to run. But to keep its edge, the company will need to remain keenly focused on ensuring the authenticity of products, which can be costly and potentially damaging to margins. REAL believers should keep an eye on costs or risk being left holding the bag.